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Are Oil Prices Too Low?

Remember peak oil? Remember when oil prices were $140 a barrel and Goldman Sachs predicted they would soon reach $200? Now, the latest news is that oil prices have gone up all the way to $34 a barrel. Last fall, Goldman Sachs predicted prices would fall to $20 a barrel, which other analysts argued was “no better than its prior predictions,” but in fact they came a lot closer to that than to $200.

Low oil prices generate huge economic benefits. Low prices mean increased mobility, which means increased economic productivity. The end result, says Bank of America analyst Francisco Blanch, is “one of the largest transfers of wealth in human history” as $3 trillion remain in consumers’ pockets rather than going to the oil companies. The Antiplanner wouldn’t call this a “wealth transfer” so much as a reduction in income inequality, but either way, it is a good thing.

Naturally, some people hate the idea of increased mobility from lower fuel prices. “Cheap gas raises fears of urban sprawl,” warns NPR. Since “urban sprawl” is a made-up problem, I’d have to rewrite this as, “Cheap gas raises hopes of urban sprawl.” The only real “fear” is on the part of city officials who want everyone to pay taxes to them so they can build stadiums, light-rail lines, and other useless urban monuments.

A more cogent argument is made by UC Berkeley sustainability professor Maximilian Auffhammer, who argues that “gas is too cheap” because current prices fail to cover all of the external costs of driving. He cites what he calls a “classic paper” that calculates the external costs of driving to be $2.28 per gallon. If that were true, then one approach would be to tax gasoline $2.28 a gallon and use the revenues to pay those external costs.

The only problem is that most of the so-called external costs aren’t external at all but are paid by highway users. The largest share of calculated costs, estimated at $1.05 a gallon, is the cost of congestion. This is really a cost of bad planning, not gasoline. Either way, the cost is almost entirely paid by people in traffic consuming that gasoline.

The next largest cost, at 63 cents a gallon, is the cost of accidents. Again, this is partly a cost of bad planning: remember how fatality rates dropped nearly 20 percent between 2007 and 2009, largely due to the reduction in congestion caused by the recession? This decline could have taken place years before if cities had been serious about relieving congestion rather than ignoring it. In any case, most of the cost of accidents, like the other costs of congestion, are largely internalized by the auto drivers through insurance.

The next-largest cost, pegged at 42 cents per gallon, is “local pollution.” While that is truly an external cost, it is also rapidly declining as shown in figure 1 of the paper. According to EPA data, total vehicle emissions of most pollutants have declined by more than 50 percent since the numbers used in this 2006 report. Thus, the 42 cents per gallon is more like 20 cents per gallon and falling fast.

At 12 cents a gallon, the next-largest cost is “oil dependency,” which the paper defines as exposing “the economy to energy price volatility and price manipulation” that “may compromise national security and foreign policy interests.” That problem, which was questionable in the first place, seems to have gone away thanks to the resurgence of oil production within the United States, which has made other oil producers, such as Saudi Arabia, more dependent on us than we are on them.

Finally, at a mere 6 cents per gallon, is the cost of greenhouse gas emissions. If you believe this is a cost,
it will decline when measured as a cost per mile as cars get more fuel efficient under the current CAFE standards. But it should remain fixed as a cost per gallon as burning a gallon of gasoline will always produce a fixed amount of greenhouse gases.

In short, rather than $2.38 per gallon, the external cost of driving is closer to around 26 cents per gallon. Twenty cents of this cost is steadily declining as cars get cleaner and all of it is declining when measured per mile as cars get more fuel-efficient.

It’s worth noting that, though we are seeing an increase in driving due to low fuel prices, the amount of driving we do isn’t all that sensitive to fuel prices. Real gasoline prices doubled between 2000 and 2009, yet per capita driving continued to grow until the recession began. Prices have fallen by 50 percent in the last six months or so, yet the 3 or 4 percent increase in driving may be as much due to increased employment as to more affordable fuel.

This means that, though there may be some externalities from driving, raising gas taxes and creating government slush funds with the revenues is not the best way of dealing with those externalities. I’d feel differently if I felt any assurance that government would use those revenues to actually fix the externalities, but that seems unlikely. I actually like the idea of tradable permits best, but short of that the current system of ever-tightening pollution controls seems to be working well at little cost to consumers and without threatening the economic benefits of increased mobility.

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18 thoughts on “Are Oil Prices Too Low?”

In 2007 in the comments of this blog, a narcissistic planner troll proclaimed that “$6.00/gal gas [will] hit us, [and] TODs will become hot commodities, thereby giving people freedom of choice.” Someone asked, “What if gas goes to $2 per gallon instead?” No answer was given by the know-it-all planner troll.

Of course as the petro industry is starting to suffer and thousand of people are losing their jobs down here in TX. I thought this post would have touched on weather or not super cheep gas is actually good for the economy opposed to it helping us drive more. As many of the oil rich markets around the world approach default, one has to wonder if we will stop rejoicing at the pump once we realize that cheep gas is leading to economic collapse.

“…cheep gas is leading to economic collapse.” That is true if the stock market/bond markets were inflated due to a “bubble” based on high gas prices. Low gas prices are not the villain – the villain was high prices brought about by rampant speculation and greed, causing a bubble that would inevitably burst.

@Bennett, I live in Houston. The media keeps telling us the sky is falling. There is hardly any evidence of that except in areas where there was a great deal of shale drilling, mainly the Barnett, Pearsall and Eagleford shale basins. In the major cities of the Texas Triangle very little has changed. In fact, places like Austin and San Antonio have stayed red hot.

@Jardinero1. The boom in the Eagle Ford region is no joke. Towns like Crystal City and Carrizo Springs were little more than a 4 way stop a few years ago and now have several new hotels and industry. A lot of that is leaving already. Of course the 4th largest city in the US can survive a economic downturn… for now. I fail to see how we aren’t going to feel the impact of cheep oil prices when major markets around the world start to default. This first domino to fall is likely Venezuela, but Russia and others may not be far behind.

The appropriate way of asking whether something is “good for the economy” is to ask “is it good for consumers?” High prices may benefit a few at everyone else’s expense. They are not “good for the economy.” Low prices mean more overall productivity because people will be able to buy more things with their incomes. Mobility is also important because it means the costs of transporting goods and services are lower.

A major reason–perhaps the major reason–that oil prices have taken a slump lately is that the Saudis refused to cut production in a bid to undermine additional shale and fracking production in the U.S. To that, add the inevitable correction in the Chinese economy that is overdue.

Whether the Saudis have succeeded in wiping out the Bakken and other areas remains to be seen, but in the meantime they’ve cut their own revenue throats. How long we’ll see low prices remains to be seen, depending on whether the Russians and Saudis can force prices up again by finally cutting their production. If the worldwide economy tanks starting in China, I fail to see the “benefits” of current low oil prices.

Good news! With low oil prices, it will now be cheaper for msetty and other planners to be flaming hypocrites and live in the country or exurbs instead of the high density apartments the “rest of us” should be caged in.

Haha. Mshitty is just experiencing sour grapes because of the relationship between wine prices and oil prices. His ranch may go under! Then what will he do? Move to SF and live in a 200 sq ft apartment and work at a productive job? haha

Looks like mshitty has a strong bias against those with mental illness, which is unfortunate as they are transit’s main customers. He likely intentionally isolates himself on a grape ranch not served by transit so he doesn’t have to interact with the mentally ill. What a sadsack.

”
A major reason–perhaps the major reason–that oil prices have taken a slump lately is that the Saudis refused to cut production in a bid to undermine additional shale and fracking production in the U.S. To that, add the inevitable correction in the Chinese economy that is overdue.
”
~msetty

@msetty, I don’t mean to single you out; just an example of a much repeated claim that is going around. It is, IMHO, an excellent example of “everyone needs a cover story”. This story serves the house of Saud well.

a) Fracking has been around for a long time; the modern “perfection” of the process has been around for several years. If the current oil price can be affected by Saudi Aramco the way some [ simpletons ] claim, they would’ve tanked oil prices years ago to kill the industry. One does stop mice from spreading by letting them live long enough to reproduce.

b) The new regime in Saudi Arabia, just like the previous regime, needs a “reason” for their economic woes that come from low oil prices. Short of shutting off half their spigots and the mass unemployment that comes from that, they can at least claim to have a plan and control over the problems with their weakened economy.

c) see b; the volume reduction needed to affect prices would come w/ a huge risk of having a lot of unemployed people at home twidling their thumbs and thus risking politicial instability at the very time the new regime is trying to establish power ( aka, they’re vunerable ).

d) Almost all of the capital for a well is sunk upfront. Once you’ve reached the point of pumping, there is no use in turning it off. IN fact, you can’t just turn it off. Shutting it off costs you money and time.

f) Get cash while you can. Point D plays into this along with msetty’s observation on China. In fact, it’s not just a downturn. It’s the end of a supercycle. Commodities have a historical cyle of a good decade followed by very weak pricing for the next two decades. Why shut off the pumps when prices are going to drop either way? The are getting the cash for their oil while it’s there.

A, B, C, D, E, and F together are huge. The house of Saud isn’t cutting production because it’s impossible to reduce by the quantity needed w/out creating political risks to their hold on power. They aren’t cutting production because the price is screwed and going to be there for a generation regardless of what anyone does for another generation.

With oil in the duldrums, the new regime in Rihayd has embarked on a new approach to holding onto power, becoming a regional power. As we’ve seen in Yemen, it’s probably a foolish quest. But it at least gives them a different line of rhetoric while the house of Saud tries to continue to head Saudi Arabia and the Bedouins try to retain the HiJaz.

”
I fail to see how we aren’t going to feel the impact of cheep oil prices when major markets around the world start to default. This first domino to fall is likely Venezuela, but Russia and others may not be far behind.
”
~ bennet

Of course it’ll make a difference. You’re point though is rather disjointed. There’s an important distinction between will it have an impact and how much of an impact it will have. It will have an impact but it will not be a disaster for the US. Modern history is full of these commodity price drops. Life will go on for us.

As for places like Venezuela or Russia, what exactly is the point? Venezuela became a country on the brink of being a failed state ( aka South America’s Pakistan ) back when oil prices were well north of $100 / barrel.

As for Russia, it’s in a different position today. They don’t have the same empire draining their core wealth. While it’s not a great economy, the Russian economy is more robust than a generation ago.

Whether the Saudis have succeeded in wiping out the Bakken and other areas remains to be seen, but in the meantime they’ve cut their own revenue throats. How long we’ll see low prices remains to be seen, depending on whether the Russians and Saudis can force prices up again by finally cutting their production. If the worldwide economy tanks starting in China, I fail to see the “benefits” of current low oil prices.

This is a good point. When this Saudi strategy was first announced a couple of years ago I was skeptical that they could make it work. Not only would it involve substantial harm to their domestic economy, at least in the short term, but I also thought that they had significantly underestimated the degree to which they are “price takers” on the global market. Saudi Arabia seems committed to this strategy and does have substantial assets in the form of sovereign wealth funds that can help it weather the problems that low oil prices will produce in the short term.

The key question is how far will they be willing to go to pursue such a strategy, and how much wealth will they be willing to burn through to see if it succeeds. There has already been collateral damage to other OPEC members, as has been widely reported. Of course, the “driving out” of U.S. producers is also a policy that, to the extent that it is successful, can really only be successful in the short run. Production can’t ramp up overnight, but at the same time, an extended period of high prices will encourage re-entry into the market. The good thing about the contemporary global oil market is that it is much more decentralized than it was a generation ago. This limits the ability of any one player to dominate supply, not just in physical terms, but because it makes efforts to collude to reduce supply more difficult not only to negotiate, but to maintain.

Lastly, regarding China, if the global economy does stagnate or sink into recession, it won’t be because of low oil prices. China is not a large producer of liquid fuels. It is, however, a large consumer, which means that low prices for oil are likely to have a net positive effect on its domestic economy. Any reductions in earnings to domestic producers are likely to be more than offset by the savings to domestic consumers, both residential and commercial. And, to Bennett’s point, the same can largely be said of the U.S.